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Policy rules and targets: framing the central banker's problem


  • Stephen G. Cecchetti


The author presents an analytical framework for the formulation of a central bank policy rule and examines some conceptual issues relating to the current debate over the effectiveness of such rules. In discussing the move by many central banks to adopt a price-level or inflation rate target--the basis for one type of rule--he suggests that central banks are implicitly changing the relative importance they attach to the goals of price and output stability. Using 1984-95 data, he shows that an effort to decrease inflation variability modestly could cause output to deviate significantly from its optimal path. The essay also addresses the influence of various types of uncertainty on policymaking, the possible justifications for interest rate smoothing, and the consequences of the fact that nominal interest rates cannot fall below zero.

Suggested Citation

  • Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14.
  • Handle: RePEc:fip:fednep:y:1998:i:jun:p:1-14:n:v.4no.2

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    References listed on IDEAS

    1. Cukierman, Alex & Kalaitzidakis, Pantelis & Summers, Lawrence H. & Webb, Steven B., 1993. "Central bank independence, growth, investment, and real rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 95-140, December.
    2. Erica Groshen & Mark Schweitzer, 1999. "Identifying Inflation's Grease and Sand Effects in the Labor Market," NBER Chapters,in: The Costs and Benefits of Price Stability, pages 273-314 National Bureau of Economic Research, Inc.
    3. Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(3), pages 337-361, September.
    4. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
    5. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
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    Cited by:

    1. International Monetary Fund, 2008. "Is Monetary Policy Effective When Credit is Low?," IMF Working Papers 08/288, International Monetary Fund.
    2. Soderstrom, Ulf, 2002. " Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145.
    3. Vittorio Corbo & Klaus Schmidt-Hebbel, 2001. "Inflation Targeting in Latin America," Working Papers Central Bank of Chile 105, Central Bank of Chile.
    4. Stefan Krause, 2006. "Optimal monetary policy and the equivalency between the one-period AD-AS model and the forward-looking New Keynesian model," Applied Economics Letters, Taylor & Francis Journals, vol. 13(9), pages 541-544.
    5. Sergio Destefanis, 2003. "Measuring macroeconomic performance through a non-parametric Taylor curve," CSEF Working Papers 95, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    6. Philip Arestis & Kostas Mouratidis, 2004. "Is There a Trade-Off Between Inflation Variability and Output-Gap Variability in the EMU Countries?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 51(5), pages 691-706, November.
    7. Ben Martin, 1999. "Caution and gradualism in monetary policy under uncertainty," Bank of England working papers 105, Bank of England.
    8. Stephen G. Cecchetti & Michael Ehrmann, 2002. "Does Inflation Targeting Increase Output Volatility?: An International Comparison of Policymakers' Preferences and Outcomes," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 9, pages 247-274 Central Bank of Chile.
    9. Stefan Krause & Felix Rioja, 2006. "Financial Development and Monetary Policy Efficiency," Emory Economics 0613, Department of Economics, Emory University (Atlanta).
    10. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    11. M. D. Hayford & A. G. Malliaris, 2005. "How did the Fed react to the 1990s stock market bubble? Evidence from an extended Taylor rule," World Scientific Book Chapters,in: Economic Uncertainty, Instabilities And Asset Bubbles Selected Essays, chapter 14, pages 223-232 World Scientific Publishing Co. Pte. Ltd..
    12. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-33.
    13. Söderström, Ulf, 1999. "Should central banks be more aggressive?," Working Paper Series 84, Sveriges Riksbank (Central Bank of Sweden).
    14. Robert Dittmar & William T. Gavin & Finn E. Kydland, 1999. "Price-level uncertainty and inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 23-34.
    15. Frédérique SIBI, "undated". "Stability of Final Objective of the European Monetary Authorities," EcoMod2004 330600129, EcoMod.
    16. Canofari, Paolo & Di Bartolomeo, Giovanni, 2017. "Regime switches under policy uncertainty in monetary unions," European Journal of Political Economy, Elsevier, vol. 47(C), pages 124-132.
    17. Marc-Alexandre Sénégas, 2002. "La politique monétaire face à l'incertitude : un survol méthodologique des contributions relatives à la zone euro," Revue d'Économie Financière, Programme National Persée, vol. 65(1), pages 177-200.
    18. Warwick J. McKibbin & Kanhaiya Singh, 2000. "Issues in the Choice of a Monetary Regime for India," ASARC Working Papers 2000-01, The Australian National University, Australia South Asia Research Centre.
    19. Kenneth N. Kuttner & Adam S. Posen, 1999. "Does talk matter after all? Inflation targeting and central bank behavior," Staff Reports 88, Federal Reserve Bank of New York.
    20. J. Kilponen & Marc-Alexandre Sénégas & J. Vilmunen, 2006. "Bayesian versus robust control approach towards parameter uncertainty in monetary policymaking: how close are the outcomes? Some illustrating evidence from the EMU economies," Post-Print hal-00150522, HAL.
    21. Ronald G. Bodkin & Angel Enrique Neder, 2003. "Monetary Policy Targeting in Argentina and Canada in the 1990s: A Comparison, Some Contrasts, and a Tentative Evaluation," Eastern Economic Journal, Eastern Economic Association, vol. 29(3), pages 339-358, Summer.
    22. William T. Gavin, 2000. "Controlling inflation after Bretton Woods: an analysis based on policy objectives," Working Papers 2000-007, Federal Reserve Bank of St. Louis.


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